Britain 'must not slip' on deficit cut

World bank and IMF IMF warns of renewed turmoil in financial markets. Diane Coyle reports from Washington

The International Monetary Fund has downgraded its forecasts for growth in Britain and the other industrial countries this year and next. It also issued a sharp warning yesterday of the risk of more turbulence in the financial markets unless governments improve their economic policies.

Britain is one of the countries it says must not slip on plans to cut the government deficit. "We do not believe the fiscal position in Britain allows room for net tax cuts," said Michael Mussa, the IMF's Economic Counsellor. He also refused to rule out the possibility that base rates might need to rise again. Although agreeing that the economic slowdown had removed the urgency, he said: "It is too early to make a judgement that short-term interest rates have peaked."

The IMF, setting the scene for the G7 meeting in Washington this weekend, reckons that most industrial economies will expand more slowly than it envisaged earlier this year.

The report says that inflation is unlikely to pick up much in the industrial countries generally. But it says: "Barring stronger efforts to reduce fiscal deficits than currently envisaged, only a few countries appear to have significant scope for further monetary easing." It puts Britain firmly in the category of countries needing to improve financial market credibility by holding a firm line on interest rates and deficit reduction.

The British economy is forecast to expand by 2.7 per cent his year, half a per cent below both the Treasury's forecast and the IMF's own earlier prediction. Just weeks before the 28 November budget, the IMF warns the Chancellor that efforts to cut the Government's borrowing requirement must not slip. It also says that the current pause in growth should not be exaggerated.

The US gets the same caution from the IMF's economists. Only evidence of a marked slowdown in economic activity would warrant significant cuts in interest rates. The key issue for American policymakers, however, is eliminating the fiscal deficit. The IMF has revised its forecast of US growth to a slightly lower 2.9 per cent this year and 2.0 per cent in 1996.

The broadly favourable economic outlook, with reasonable growth and low inflation in most countries, could be in jeopardy if governments do not grasp this nettle. "These risks derive partly from policy weaknesses in many industrial countries that may provoke renewed turbulence in financial markets," says the report.

It picks out the US, France, Italy, Spain and Sweden as countries in urgent need of deficit cuts and in some cases additional labour market reforms. But the IMF argues that the sensitivity of financial markets to inappropriate economic policies - such as excessive budget deficits or lack of credibility in interest rate setting - is increasing.

The report argues that almost all industrial countries need to tackle excess government deficits. The emphasis needs to be on expenditure cuts, especially spending on pensions and healthcare.

The IMF's forecasts for growth in developing countries have been revised up since April. The repercussions of the Mexico crisis have been successfully contained, with only Argentina seriously affected. Average growth in the Asian developing countries is likely to exceed more than 8 per cent this year, for the fourth year in a row. Private capital flows to the developing countries have now returned to a high level, although financial markets have become more selective.